Facebook Drives SecondMarket Broking $1 Billion Private Shares

Facebook Inc. logos are displayed on computer screens. Some of the shares of private, venture-backed social-media companies such as Facebook Inc., LinkedIn Corp. and Twitter Inc. have doubled over the past year. Photographer: Daniel Acker/Bloomberg

By age 10, he was swapping baseball cards at collectors
conventions. At 15, he plowed his savings into shares of
Chromatics Color Sciences International Inc. -- a penny stock
that lost him $2,000. And as a 25-year-old banker for the
creditors of Enron Corp., Silbert traveled the globe after the
firm’s 2001 bankruptcy, flogging Enron assets, including fiber-optic cable and Bolivian pipelines.

He’s been a registered broker since he was 17, Bloomberg
Markets magazine reports in its June issue.

Today, Silbert, 34, is the best-known player in a sizzling
market: the trading of shares of private, venture-backed social-media companies such as Facebook Inc., LinkedIn Corp. and
Twitter Inc. As chief executive officer of New York-based
SecondMarket Holdings Inc., he is building the go-to forum for
trading these boldfaced shares, some of whose prices more than
doubled in the 12 months ended in mid-April.

Those rising stock valuations are turbocharging
SecondMarket -- and making Silbert rich. SecondMarket says it’s
the world’s biggest broker of venture-backed private-company
stock by the value of shares traded. The firm’s private-company
transactions, which totaled $100 million in 2009, quadrupled by
2010 to $400 million.

Based on first-quarter results, SecondMarket could broker
$1 billion in private-company shares in 2011, taking fees of
from 3 to 5 percent on each trade.

Changing the World

Silbert wears his sandy-blond hair brushed forward -- and
looks 10 years younger than his age. Like a lot of tech-driven
entrepreneurs, he is certain his venture is changing the world.

“The money that we are freeing up is being reinvested in
other venture-backed startups -- and creating jobs,” Silbert
says. “This market we’re building is critical to the whole
capital-formation process.”

The shares of private companies have become a hot market --
and a hot topic. The value of all private-share transactions was
$4.6 billion in 2010, up from $2.4 billion in 2009, according to
Rye Brook, New York-based broker-dealer and research firm Nyppex
Holdings LLC. The volume, the firm says, could climb to almost
$7 billion this year. Silbert says much of that is coming
SecondMarket’s way.

“We’ve heard expressions of interest from holders of stocks
in thousands of private companies,” he says.

Hot Properties

Investors are eager to get their hands on the private stock
of such companies as Facebook and Twitter in anticipation of big
profits when they go public, and investment banks are scrambling
to offer their clients the chance to buy in. Yet, the shares
trade in a sometimes opaque market that is open only to a
relatively privileged class.

In January, Goldman Sachs Group Inc. withdrew the U.S.
portion of an offer to sell $1 billion in Facebook shares to
clients because the media attention surrounding the offering
“might not be consistent” with securities laws. Goldman, which
had itself invested in the company, then sold the $1 billion
Facebook stake to non-U.S. clients, giving the company an
implied valuation of $50 billion.

Some Securities and Exchange Commission strictures may ease
soon. On April 6, SEC Chairman Mary Schapiro, in a 26-page
letter responding to an inquiry from California Representative
Darrell Issa, said she was considering raising from 499 the
number of shareholders a private company can have without making
financial disclosures to the commission. Such a change could
increase the market for private shares by broadening the pool of
potential investors in any one company.

SEC Inquiry

The SEC also sent a letter of inquiry to private-share
brokers, including SecondMarket, regarding pooled investment
funds that sink money into private-company shares, SecondMarket
spokesman Mark Murphy says. David Weir, CEO of SecondMarket
rival SharesPost Inc., says his company also received a request
for documents. Although Silbert personally owns stakes in a
half-dozen Internet startups, none trade on SecondMarket, he
says.

The regulators have yet to address what some analysts see
as the fundamental issue: allowing private-company shares to
trade in quasi-public markets without full disclosure. John
Coffee, a professor of securities law at Columbia University,
says participants in the private-share market face what he calls
“informational asymmetries” -- meaning that insiders in private
companies are likely to have far more knowledge of corporate
performance than outsiders buying in.

Sophisticated Investors

Silbert says his clients know they are taking chances.

“Institutional investors are sophisticated and understand
the risks,” he says.

Second-Market’s most serious competitor is San Bruno,
California-based SharesPost. Other rivals include Gate
Technologies LLC in New York and Xpert Financial Inc. of San
Mateo, California. Investment banks also buy and sell private-company shares for their clients, sometimes via SecondMarket.
Venture-capital firms that want to buy or sell shares often use
SecondMarket or its competitors, or trade informally among
themselves and with employees or former employees of private
venture-backed companies.

How much financial information do companies whose shares
trade on SecondMarket have to disclose? As much or as little as
they want. SecondMarket provides its customers only the
financial data that firms are willing to provide.

‘Dearth of Information’

“There’s a real dearth of information about these
companies,” says Larry Tabb, CEO of Tabb Group Inc., a capital-markets research firm. “Are investors trading blind? With
illiquid securities, you almost have to be.”

SecondMarket is booming partly because fast-growth tech
companies are shying away from initial public offerings.
According to the National Venture Capital Association Yearbook
2011, there were 72 venture-backed IPOs in 2010, compared with
271 in 1999. The median interval between when such a company is
founded and when it goes public rose to nine years in 2010 from
just four years in 1999.

Two reasons are the onerous financial disclosure and
additional accounting required under the Sarbanes-Oxley Act,
passed after the accounting scandals of 2000 to 2002, says Alan
Patricof, founder of venture firm Greycroft LLC. In addition,
many of the smaller investment banks that used to underwrite
tech IPOs have been bought by larger institutions. Analyst
coverage of newly public startups has fallen, making investors
wary, Patricof says.

Accredited Investors Only

The Securities Act of 1933 restricts purchases of private-company stock to what it defines as “accredited” investors. In
the case of individuals, that means people with a net worth of
at least $1 million or $200,000 in annual income. In Coffee’s
view, inflation has made the standards less meaningful.

“It allows the middle class to enter into a dangerous world
of limited information and fluctuating liquidity,” he says.

Silbert characterizes SecondMarket as an EBay for illiquid
assets. Companies may opt for open trading in their shares or
for quarterly or annual offerings. Most trading is initiated via
phone or the firm’s website. The sellers are usually former
employees and early-stage venture capitalists. The buyers are
hedge funds, wealthy investors and other VCs.

Sellers can post their offering price and the number of
shares they are selling. Buyers either agree to that price, make
lower bids or use the site to set up meetings to negotiate
offline. Companies publish whatever financial information
they’re willing to disclose on a secure section of the website
to which only participants in a transaction have access.

Beyond Ebay

Silbert wants to move beyond the EBay model by adding
social-networking functions. Participants can now list their
holdings, post strategies and create watch lists of those
companies they’re most interested in. In the future, they will
also be able to swap messages, Silbert says.

Coffee says markets like Silbert’s look better than they
work.

“These private secondary markets give the illusion, but not
the reality, of liquidity,” he says. “They are matching systems,
and the broker does not function as a dealer committing its own
capital. In a period of market distress, liquidity will vanish.”

Even today, days or weeks can go by without shares of even
big private-company stocks changing hands.

A look at Facebook trades published by SecondMarket
competitor SharesPost shows that private shares are a market of
which buyers should beware. In January, investors agreed to
trade a small lot of Facebook stock for $60 a share, more than
twice the price that other investors agreed to pay the very same
day. SharesPost CEO Weir says his company’s brokers now review
price postings before they go live.

SecondMarket doesn’t disclose the price at which shares are
bought and sold on its network.

Illiquid Assets

Silbert trades more than just the shares of startups. The
broker-dealer has staked out a slew of other tough-to-trade
asset classes in which it matches buyers and sellers, among them
bankruptcy claims, mortgage-backed securities and limited
partnerships in hedge funds.

One new customer is Pacific Investment Management Co., a
subsidiary of Munich-based Allianz SE, with $1.24 trillion in
assets under management as of December. Pimco shares can be
traded only by employees of the Newport Beach, California-based
firm, which uses shares as performance-based compensation.
SecondMarket is also targeting the private shares of big
companies such as Cargill Inc. and Levi Strauss & Co.

“We’re scratching the surface of what we can do,” Silbert
says.

53,000 Participants

In late 2007, a former Facebook employee approached the
firm and asked whether it could help unload some shares. A
separate private-company desk was created in April 2009. As of
March, Facebook shares, which trade at weekly auctions,
accounted for more than 40 percent of SecondMarket’s private-company transactions. In March, its Web-based network for
traders of all of its asset classes had 53,000 registered
participants, up from 35,000 in 2010, 6,500 in 2009 and 2,500 in
2008.

Facebook spokesman Jonathan Thaw says the company, co-founded and run by Mark Zuckerberg, effectively bans current
employees from trading its stock.

“We implemented an insider-trading policy last year to
better comply with insider-trading laws and to protect the
interests of the company and its employees,” he says.

Private gaming company Zynga Inc. also forbids its
employees from selling, except during designated trading
windows.

Insider Trading Concern

“This policy is in place because employees have information
about the company that’s not publicly available and might expose
them to the risk of insider trading,” says Karyn Smith, Zynga’s
deputy general counsel.

Silbert swiped a page or two from Facebook’s game plan in
March, when SecondMarket vastly expanded its website. While
investors could trade in just 50 stocks as of mid-April,
SecondMarket also profiles on its website thousands of other
private companies whose shares might trade in the future. That
number is now 12,500, up from 550.

Participants flag those companies they want to keep tabs
on, giving SecondMarket a crowd-sourced barometer of the
interest in each firm. Site registrants can also state their
willingness to buy shares -- giving SecondMarket a tool with
which to persuade companies to allow their stock to trade on its
network.

Seller’s Market

Silbert’s growing customer base has tracked the soaring
price of Facebook stock. Buyers and sellers signed off on a
trade of $10 a share in April 2010, implying a valuation of
$22.7 billion, according to SharesPost. By mid-April of
this year, the price had risen to $32.50 a share, or $73.7
billion -- more than the real-world market capitalization of
EBay Inc. or 3M Co.

By that measure, the overseas Goldman clients who paid $1
billion for Facebook shares in January earned a 47 percent paper
return in three months.

Lou Kerner, an analyst at Los Angeles-based investment bank
Wedbush Inc., estimates that Facebook’s earnings before
interest, taxes, depreciation and amortization were $1 billion
in 2010 on revenue of $2 billion. Using a higher implied
valuation than SharesPost, he concludes its stock was trading at
78 times Ebitda in mid-April.

$100 Billion

Bloomberg data showed Google Inc. and EBay trading for
about 14 times Ebitda.

“People aren’t buying Facebook for its revenues in 2010,”
Kerner says. “They’re buying it for what it’s going to be doing
in 2015. We believe if it were public, it would be worth in
excess of $100 billion.”

Other social media companies whose shares SecondMarket
trades are also ablaze. SharesPost says prospective buyers and
sellers of preferred shares of Twitter settled on a per-share
price of $30 in March, up from $11.67 in April 2010.

In December, Chicago-based Groupon turned down a $6 billion
buyout offer from Google, the Mountain View, California-based
search engine giant. Groupon, which sells coupons for goods and
services after negotiating big discounts from merchants, is
considering a public offering that values the company at as much
as $25 billion, two people familiar with the matter said
in March.

Leap of Faith

Investors using SecondMarket and SharesPost to load up on
venture-backed private-company shares are taking a leap of
faith, says Stephen Grant, a private-equity banker at Internet
Securities Inc. in Oakland, California.

“From a fundamental standpoint, it’s ridiculous: There are
no fundamentals, just a couple of P&L figures,” Grant says.
Still, he says there’s a logic to the clamor to buy Facebook
shares. “What people are buying is Facebook’s 600 million active
users,” Grant says. “They are heading toward a billion, and
that’s one-seventh of the world’s population as your customer
base.”

Silbert says his role isn’t to judge whether social-networking stocks are a bubble -- though he points out that
plenty trade for far lower valuations than Facebook.

“It’s not up to us to determine what the fair market value
is,” he says.

His mission, instead, is to get private companies
comfortable with the idea of trading their shares.

‘Empowering’

“We work with issuers to arrive at a solution that works
for them,” Silbert says in his 12th-floor office in Manhattan
overlooking Bowling Green. “Companies are growing to realize
that this kind of trading is empowering. It’s great for the
employees and the company.”

Silbert lets each listing company decide how often its
stock can trade, whether current employees can buy or sell and
whether institutions such as hedge funds are allowed to buy. His
3 to 5 percent fee is split evenly between buyer and seller.

A SecondMarket registered broker called a market specialist
vets the buyer to make sure he or she is accredited and meets
with the approval of the issuer, which almost always has a right
of first refusal on share transfers. A separate operations
specialist ensures compliance with anti-fraud and money-laundering regulations. The broker shepherds everyone through
the legal and accounting paperwork, ultimately overseeing the
settlement of the transaction.

“SecondMarket has been the leader in standardizing the
process -- the vetting, the lawyering,” says William Martin,
founder of Raging Capital Management LLC, a $125 million hedge
fund that has used SecondMarket to buy social media stock,
including Facebook. “They’ve succeeded in attracting the buyers
and the sellers.”

Playing Foosball

Signs of prosperity abound at SecondMarket’s offices, whose
walls are painted in bright colors of green, blue and orange.
Last winter, the firm increased its office space from 19,000
square feet (1,770 square meters) to 26,000 square feet. It
includes a game room where Silbert plays foosball with some of
his 135 employees. He can also be found on Friday afternoons
knocking back Stella Artoises at SecondMarket’s end-of-week
parties.

Silbert has reeled in a diverse cast of enthusiasts,
including college friend Jeremy Smith, 35, head of strategy for
SecondMarket, and Adam Oliveri, 27, who joined in 2005 just
after graduating from the University of Rhode Island and heads
the private-company marketplace. Former Google product manager
Dominic Preuss, 33, is SecondMarket’s technology chief.

Matching Game

Silbert’s success at matching buyers and sellers has made
SecondMarket’s own private shares valuable. In February 2010,
Singapore’s sovereign-wealth fund Temasek Holding Pte and Hong
Kong-based Li Ka-shing Foundation Ltd., which helped bankroll
Facebook, together bought a combined 10 percent stake in
SecondMarket for $15 million, valuing the company at $150
million.

Trading private-company shares remains a relatively small
business. SecondMarket produced revenue of $16 million on the
$400 million of private-company transactions it handled in 2010.
Even if the transaction value surges to $1 billion, private-company trades would generate only $40 million in revenues.

“This is not a big asset class,” says managing director
Hans Swildens of Industry Ventures LLC, a San Francisco-based
investment firm. “It has been a niche business and will continue
to be a niche business.”

Silbert says there is plenty of room for growth.

“Three-thousand companies are funded by VCs every year,” he
says.

Mowing Lawns

Silbert, who grew up in Gaithersburg, Maryland, was an
entrepreneur from an early age.

“I was the kid mowing lawns; I was the kid shoveling
driveways,” he recalls. Silbert would turn a profit trading
baseball cards with grown-ups 10 years older at hobbyist
conventions. “That was my first illiquid asset,” he says.

In 1986, Silbert’s father, a government auditor, died from
an aneurysm of the main artery of the heart, and Silbert pursued
his odd jobs with even more determination, says his mother,
Andrea Epstein. He worked in a liquor store and sold greeting
cards.

“It was us against the world,” she says.

In 1994, when Silbert was 17, he got a job filing at a
mutual fund near his home. His boss, Michael Byrum, now chief
investment officer at Rydex SGI, a New York-based asset manager,
persuaded him to take the Series 7 examination, the test now
administered by the Financial Industry Regulatory Authority for
aspiring brokers. Silbert passed.

Emory Grad

He went on to earn a degree from the Goizueta School of
Business at Emory University in Atlanta. During his junior year,
he got a call from Bear Stearns Cos. Chairman Alan “Ace”
Greenberg. An acquaintance had forwarded his resume.

“I almost asked him what he did at Bear Stearns,” Silbert
says.

Silbert spent the summer working in Bear Stearns’s
international stock loan department, hunting down hard-to-find
shares for hedge-fund clients to short. Yet, when Silbert
graduated, he chose to work for a much smaller firm, Los
Angeles-based investment bank Houlihan Lokey Inc.

“They were on a bit of a mission,” he says. “They were
building a company.”

Train Wrecks

Houlihan Lokey specialized in corporate restructurings, and
it pulled in lots of new business after the global panic that
followed the 1998 Russian bond default and the meltdown of hedge
fund Long-Term Capital Management. Silbert, working out of
Houlihan’s Park Avenue offices in New York, was assigned to some
serious corporate train wrecks: the 2001 bankruptcies of speech
recognition company Lernout & Hauspie Speech Products NV and
Saul Steinberg’s Reliance Group Holdings Inc.

“He was a young eager beaver with an entrepreneurial
spirit,” says Jeff Werbalowsky, his boss at the time and co-CEO
of Houlihan Lokey.

Silbert’s biggest challenge was helping to sell off the
tangled assets of Enron, the Houston-based commodities and
energy-trading company that went bankrupt in 2001 amid charges
of massive accounting fraud. The company had subsidiaries all
over the world, many of them co-owned by minority investors.
Ultimately, Houlihan Lokey packaged most of the assets into a
holding company and distributed shares to creditors.

“Perhaps if there had been a SecondMarket then, things
would have been different,” Silbert says.

Eureka Moment

Silbert’s experience restructuring bankrupt companies gave
him the idea that there was a business in finding buyers for
hard-to-trade assets. Werbalowsky says he was skeptical, telling
Silbert he would be tripped up by, for example, state and
federal securities regulations.

“We can work it out,” Silbert would insist.

Silbert drafted a business plan for his company in 2004,
calling it Private Company Stock Exchange. He laid out $2,000
for the Web URL PCSE.com, dubbing the company “the EBay of
private-company stock.” A lawyer soon pointed out that he
couldn’t call his operation an exchange unless he registered as
one.

“I flushed $2,000 down the drain,” Silbert says.

Silbert tried again, launching a business with the help of
a $300,000 investment from a former brokerage executive he
declines to name on the record. The investor suggested it would
be easier to trade restricted stock of public companies than
private-company shares because holders are registered and
prospective buyers such as mutual funds are easy to find, as
they are required to disclose their holdings to the SEC.

Trading Restricted Stock

Such stock is awarded to executives as compensation and
often can’t be sold for a period of years.

In late 2004, Silbert’s firm became Restricted Securities
Trading Network, which he says made a profit in its first year,
2005, and every year since.

By late 2006, RSTN was e-mailing lists of restricted stock
to potential buyers. Silbert soon set up a password-encoded
bulletin board allowing sellers to post their holdings. Revenues
hit $2.5 million.

In 2007, Silbert learned that Goldman Sachs was building
its own system for buying and selling illiquid securities.
Silbert decided he might need more money.

“I never wanted to look back and say, ‘If we had had that
money, Goldman Sachs wouldn’t have crushed us,’” he says.

Venture Investor

By mid-2007, the early stages of the collapse of the market
for securities backed by subprime housing loans was under way,
setting in motion the crisis that would eventually spread to the
larger economy. Lawrence Lenihan, CEO of FirstMark Capital LLC,
saw Silbert’s company, by then called Restricted Stock Partners,
as a play on the emerging crisis.

“We were looking for businesses that would benefit in an
economic meltdown,” Lenihan says. “We knew there would be a lot
of illiquid assets.”

FirstMark invested $3.8 million for a 25 percent stake.

Beginning in early 2008, the firm moved into the nearly
frozen markets for auction-rate securities, typically bonds sold
by municipalities whose interest rates were designed to reset
periodically through bank-orchestrated auctions. In February,
banks balked and the auctions failed. SecondMarket announced it
would match buyers and sellers of auction-rate securities; it
oversaw deals that had them trading for as little as 50 cents on
the dollar. Still, bondholders rejoiced.

“We were getting flowers and chocolates,” Silbert says.

Bankruptcy Claim Market

Companies began running out of money, and in July 2008 the
company started trading bankruptcy claims. It changed its name
to SecondMarket in September.

In late 2008 and early 2009, hedge funds such as D.E. Shaw
& Co. and Citadel LLC threw up so-called gates to keep investors
from withdrawing capital. In January 2009, Second-Market set up
a desk for investors to trade hedge-fund limited-partnership
“interests.” Now, SecondMarket offers hedge funds the
opportunity to monitor and manage the trading of their own
partnership interests themselves.

“Honestly, there’s no one else who does what we do,”
Silbert says.

In April 2009, SecondMarket started a desk for mortgage-backed securities and collateralized debt obligations -- bundles
of debt sliced into tranches with different yields and
prepayment streams and sold by banks to investors. All told,
SecondMarket has completed more than $14 billion of sales of
structured products.

Silbert and his colleagues say there are categories of
illiquid assets they have yet to tap. Kevin O’Connor, co-head of
structured products at SecondMarket and a former head of
JPMorgan Chase & Co.’s auction-rate securities trading, says
there’s enormous room for expansion.

‘Wood to Chop’

“There is plenty of wood to chop,” O’Connor, 44, says. “Our
job is to find other areas that are underserved.”

The firm is now exploring markets in private real-estate
investment trusts and shares of community banks.

Bigger volumes will come from bigger game: shares of large
private companies such as Mars Inc., Bechtel Group Inc. and Koch
Industries Inc., Silbert says.

“We’re talking potential markets in the trillions, not
billions, of dollars,” he says.

SecondMarket’s most serious rival for trading venture-capital-backed company stock is SharesPost. Weir, 51, its CEO,
is a former JPMorgan Chase investment banker and ex-CEO of
OffRoad Capital Corp., a firm specializing in online private
placements. Weir’s site has more registered participants than
SecondMarket -- 65,000 compared with 53,000 -- and does less
dollar volume. The average trade on SharesPost is about $200,000
with a $25,000 minimum, the company says, versus the average of
$1 million to $2 million that SecondMarket claims.

Needling Silbert

Weir needles his East Coast rival.

“We come out of a Silicon Valley mind frame, using
technology to solve the problems,” he says. “They are brokers
with phones.”

SharesPost deals exclusively in private-company shares --
not any of the other illiquid assets that SecondMarket has
cultivated.

“We are 100 percent dedicated to private-company stock,”
Weir says.

SharesPost wants to raise money directly for venture-backed
companies in the so-called primary market, instead of just
chaperoning trades of existing shares.

Seeding Startups

Silbert, meanwhile, is seeding some startups himself as an
angel investor. He’s invested about $500,000 to help bankroll
half a dozen new companies, including New York-based RealDirect
Inc., an online real-estate brokerage; Los Angeles-based
ProFounder Financial Inc., which hosts a website that allows
entrepreneurs to raise funds from their communities; and New
York-based Send the Trend Inc., an online customized fashion
accessory company.
Silbert says what these companies have in common is that the
people behind them all want to solve problems for their
customers while upending the status quo in the process --
something Silbert has been doing since he launched his new
enterprise six years ago.